November 2016 Bar Bulletin
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November 2016 Bar Bulletin

The Stockholder’s Extraordinary Contract

By Joseph E. Bringman


We all know the standard rule of contract law, drilled into our heads as first-year law students, that to modify a contract there must be mutual agreement of the parties to do so and new and independent consideration.1 That rule does not apply, however, to the contract between a stockholder and the corporation in which the stockholder has invested. In recent years, we have seen this exception to the standard rule applied with increasing frequency.

Many investors may not even realize, when purchasing a corporation’s stock, that they are entering into a contractual relationship with the corporation — whether they purchase directly from the corporation in an IPO or other offering, or from anonymous sellers on the secondary market (usually a stock exchange). But that is in fact the nature of the relationship.

It has long been recognized in this state that a corporation’s charter and its articles of incorporation “constitute contracts having a four-fold character, that is, a contract (a) between the state and the corporation; (b) between the state and the stockholders; (c) between the corporation and the stockholders; and (d) between the stockholders themselves.”2 The corporation’s bylaws also are part of the contract between the corporation and its stockholders.3

Unlike the typical contract that we learned about as 1Ls, the contract between stockholder and corporation is the subject of a statutory scheme that, as a general rule, permits the board of directors to amend or repeal the corporation’s bylaws, or adopt new bylaws — and thus change the terms of the contract — without first obtaining the stockholders’ consent or providing them independent consideration.4 And, because Washington has done away with the vested rights doctrine,5 a stockholder who objects to the amendment of an existing bylaw or the adoption of a new one has no basis to object that the amendment violates rights that he or she had under the bylaws as they existed when the stock purchase occurred.

Although Washington’s statutes do not explicitly state that the board’s power to amend, repeal or adopt bylaws is unilateral, courts interpreting similar statutory and contractual schemes in other jurisdictions have concluded that it is, and that properly adopted bylaws are binding on all of the corporation’s stockholders, whether they were adopted before or after the stockholders purchased their stock. This is because stockholders are on notice, when they purchase stock, of all provisions in the articles of incorporation and bylaws, including provisions that authorize the board to enact or amend bylaws without first obtaining stockholder approval.6

In recent years, this issue has arisen, and courts have employed this analysis, most frequently where the board of a Delaware corporation has adopted a bylaw that places the exclusive jurisdiction for a stockholder’s breach-of-fiduciary-duty claim against the corporation or its directors or officers in the courts of a single state, typically the state of incorporation.7 Thus, in Boilermakers Local 154 Retirement Fund v. Chevron Corp., the Delaware Court of Chancery upheld a corporate board’s enactment of a bylaw that required “internal affairs” litigation by stockholders against the corporation to be filed in a particular court, stating:

The certificates of incorporation of Chevron and FedEx authorize their boards to amend the bylaws. Thus, when investors bought stock in Chevron and FedEx, they knew (i) that consistent with 8 Del C. § 109(a), the certificates of incorporation gave the boards the power to adopt and amend bylaws unilaterally; (ii) that 8 Del C. § 109(b) allows bylaws to regulate the business of the corporation, the conduct of its affairs, and the rights or powers of its stockholders; and (iii) that board-adopted bylaws are binding on the stockholders. In other words, an essential part of the contract stockholders assent to when they buy stock in Chevron and FedEx is one that presupposes the board’s authority to adopt binding bylaws consistent with 8 Del C. § 109.8

The Chevron court expressly rejected arguments that the adoption of an exclusive-forum bylaw without stockholder approval is “invalid as a matter of contract law because it does not require the assent of the stockholders who will be affected by it.”9 Citing an “unbroken line of decisions dating back several generations,” the court ruled that the modification of bylaws “is the kind of change that the overarching statutory and contractual regime the stockholders buy into explicitly allows the board to make on its own.”10

Both the Delaware Supreme Court and courts outside Delaware, including the Supreme Court of neighboring Oregon in last December’s Roberts v. TriQuint Semiconductor, Inc. decision, have corroborated the Chevron court’s conclusion that the enforceability of an exclusive-forum bylaw does not depend on whether a stockholder acquired the company’s stock before or after the bylaw was enacted.11 The courts have done so even in the face of arguments that enforcement of the bylaw would be inequitable in circumstances where the corporation’s board adopted the bylaw in close time proximity to the alleged wrongdoing that underlies the plaintiff stockholders’ lawsuit.12

Thus, unlike the “typical” contract, the contract between stockholder and corporation allows the corporation’s board of directors to unilaterally change the terms of their contract by amending or repealing an existing bylaw or enacting a new bylaw. There is little that a stockholder who objects to the change in the terms of that contract can do to avoid the effect of that change short of selling their stock13 or convincing enough other stockholders to join in voting at a subsequent stockholders’ meeting to repeal the change in the bylaws or to remove the directors who voted for it.14

Joe Bringman is senior counsel at Perkins Coie LLP, where his practice focuses on securities and corporate governance litigation. He was KCBA president during the 2011–2012 membership year.

1 E.g., Jones v. Best, 134 Wn.2d 232, 240, 950 P.2d 1 (1998) (mutual assent required to modify contract); Rosellini v. Banchero, 83 Wn.2d 268, 273, 517 P.2d 955 (1974) (new consideration required to modify contract).

2 State ex rel. Swanson v. Perham, 30 Wn.2d 368, 375, 191 P.2d 689 (1948), overruled on other grounds by Seattle Trust & Savings Bank v. McCarthy, 94 Wn.2d 605, 617 P.2d 1023 (1980).

3 See Rodruck v. Sand Point Maint. Comm’n, 48 Wn.2d 565, 578, 295 P.2d 714 (1956).

4 RCW § 23B.10.200(1). The board of directors’ power to amend, repeal or adopt bylaws is limited only by statutory prohibitions on adopting bylaws that infringe on the board’s exclusive powers over substantive decisions concerning management of the corporation or that conflict with Washington statutes, the articles of incorporation or a shareholders’ agreement. Id.; RCW § 23B.02.060(4); RCW § 23B.08.010(2)(b). In addition, the board of directors may not amend, repeal or adopt bylaws where: (1) the articles of incorporation, a shareholders’ agreement or a statute reserves that power exclusively to the stockholders; or (2) the stockholders, in exercising their right and power to amend, repeal or adopt a bylaw, expressly prohibit the board from amending or repealing that particular bylaw. RCW § 23B.10.200(1)(a)–(b).

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